One of the interesting things to me is to understand specifics as they relate to a greater whole, in short(s) to see the bigger picture. Another word for this is abstraction, but abstraction does not always apply. Consider the field of expertise, morals, or simply personal development. In those cases, specifics can not simply be abstracted, rather there seems to be a trajectory from one step to the next with several overlaps, where the next step sometimes grows out as an extension of the previous step and other times as a reaction to the previous step. It could easily be argued that there’s no trajectory. Some people never change (grow? decay?) and thus their knowledge, skills, and attitude stay the same for most of their life. I know many rocks like that, people too.

Over the time, I have definitely noticed a specific change in terms of my attitude towards money. I would divide these attitudes into four stages(*). I have also noticed that different people’s attitudes about money sometimes collide, just like different types of morals collide when one person is motived by being good, the next by the law, the third by agreement, and the last by doing right. As such I have a lot of fun taking stabs at emergency funds and index investing, because I see them completely different than those who are just discovering them.

(*) Feel free to subdivide them, cut them differently, or switch them around.

Stage 0

At this stage money is something you don’t have but which you want so you can spend it on something. An apt description of the attitude towards money at this stage is that it burns a hole in your pocket. Credit, if used, is typically not handled wisely. The focus is on the (minimum) monthly payment because that is what you need to pay. If credit is not used, money is saved up to be spent. In this case, the savings account will have a swa-tooth pattern to it. This stage does most of the “struggling” because it is very much about living in the moment. With liabilities a job loss will cause instant problems.

Stage 1

Most “personal finance” education concerns stage 1. In order to avoid the struggling a 6 month emergency fund is established to protect against job loss. People also start saving money for some distant retirement where they plan to spend the money in their accounts. This is essentially a somewhat wiser way of living at stage 0. The person has realized that it may not always be possible to work. What these two stages have in common though is the work to spend or earn to buy thinking. They are mainly different in that whereas stage 0 does not care about net worth — I’m guessing because it’s effectively zero, stage 1 is busy adding up everything from retirement accounts to houses, cars, jet skis, and jewelry.

Stage 0 and stage 1 are different in degree. Stage 1 is essentially stage 0 with some savings that are only used in special circumstances. It takes a leap of imagination to reach the next two stages.

Stage 2

Here it realized that money can be used to make money to exactly the same degree as work can be used to make money. The $100 pay out in dividends every three months from a $10,000 investment is EXACTLY the same as the $100 paid for, say, 8 hours of work. People in stage 1 will object and say they they can’t live on $100 every three months. Good point! To stay in stage 1 thinking, in order to pull off stage 2, you need a 250 month emergency fun. This is so far off the 6 month emergency fund of stage 1 that it is not even a difference of degree, it is difference in kind. Different rules apply now. Now most people will not be able to save 250 months worth of regular expenses (say $60k/year) over a lifetime. There are two solutions: Earn 10 times more. Or spend 10 times less. Not everybody can do the former, but everybody can do the latter. Once it is realized that the money a stage 2 gottem from dividends, interest, covered calls, or capital gains buys exactly the same (actually the tax rate is typically lower — guess who writes the tax laws) as money earned by work, stage 2 is achieved. A person in stage 2 is equally interested in net worth, but only counts the assets that can effectively be used to make money such as stocks or funds in broker accounts and rental property. House, car, bling–bling and other consumables are not counted.

Stage 3

This stage moves beyond net worth. Here you own businesses, not stocks or funds. The businesses pay you and you are much less concerned with net worth and much more concerned about cash flow and the quality of earnings whether they be from rentals or stocks. Much effort will be spent thinking about how to maximize cash flow based on assets than cash flow based on earned income. In this stage an additional 1% of return can mean a big change in income. A 10% drop in the market can wipe out years of earlier savings. Daily stock market fluctuations easily exceed the monthly paycheck and yet you don’t worry about that.

Stage 2 and 3 are also fairly similar with stage 3 representing a more sophisticated version of stage 2. The difference is in the way the assets are managed. Stage 3 is more active.

Stage 4

The stage moves beyond money. Either you have so much money you can’t possibly spend it all or you have found ways to live without using money at all. Maybe you’re a billionaire or maybe you’re a monk. If stage 1 is struggle-independence and stage 2 and 3 are financial independence, stage 4 is economic independence and it is different in kind from stage 2 and 3.

Many thanks to BR for the check donation to the “coffee fund”.

Originally posted 2009-02-19 16:18:14.